Prior to issuing Revenue Ruling 2001-31 the Service held that coverage in brother-sister arrangements was not insurance under its economic family theory. In Field Service Advice 200125005, and Field Service Advice 200125009, however, the Service's National office recommended that the Service concede the deduction of premiums paid by an operating subsidiary to a sister insurance captive. It concluded in Field Service Advice 200125005 that contesting the deduction of these premiums raised substantial litigation hazards, noting that the Service lost on the "brother/sister" issue in Humana and Kidde Industries. Factors "such as 'hold harmless' agreements to unrelated insurers or anyone else" were not resent. The Service conceded that "no court, in addressing a captive insurance transaction, has fully accepted the economic family theory set forth in Rev. Rul. 77-316."
In addition, the taxpayer provided some support that it had a valid business reason for creating the captive. In Revenue Ruling 2002-90, a domestic holding company created a wholly-owned subsidiary to provide insurance coverage for 12 domestic operating subsidiaries that provided professional services. The operating subsidiaries provided the same "general categories of professional services." Each subsidiary operated on a decentralized basis in a separate state.None of the operating subsidiaries had coverage for less than 5 percent nor more than 15 percent of the total risks covered by the insurance subsidiary. In total the subsidiaries had "a significant volume of independent, homogeneous risks."
The insurance subsidiary was licensed in each of the 12 states in which the operating subsidiaries did business. The holding company provided adequate capital to its insurance subsidiary but there was no parental guarantee and there were no related party guarantees. The insurance subsidiary loaned no funds to its parent or the operating subsidiaries. The Service concluded that the insurance subsidiary provided insurance to the operating subsidiaries. It reasoned that the operating subsidiaries' professional liability risks were shifted to the insurance subsidiary. The premiums paid were arms-length and were "pooled such that a loss by one operating subsidiary was borne, in substantial part, by the premiums paid by others."
In addition, the insurance and operating subsidiaries conducted themselves in all respects as would unrelated parties to a traditional insurance relationship, and [the insurance subsidiary]was regulated as an insurance company in each state where it did business."
